What is the Stock Market?
Stock markets are public markets for buying and selling stocks on stock exchanges or off-exchange. Stocks (also known as equities) represent fractional ownership of a company. The stock market allows investors to buy and sell ownership.
Stock markets that function efficiently are considered crucial to economic growth since they allow companies to access capital quickly from the public.
Stock Market Purposes –Capital Investment Income
Stock markets serve two important functions. First, it provides capital for companies to expand and fund their business. Suppose a company sells one million shares at $10 per share initially. In that case, it will have $10 million in capital to use for its business growth (minus any fees paid to an investment bank for managing the stock offering). Stock shares are a better option than borrowing money to expand the business. The company can avoid debt and interest costs by offering the stock instead.
The stock market’s secondary purpose is to allow investors to participate in the profits made by publicly traded companies. Stock buying can be profitable for investors in two different ways. Some stocks pay dividends regularly (a certain amount per share of stock that someone owns).
Investors can also profit by buying stock and selling it at a higher price if their purchase price rises. If an investor purchases shares of stock in a company at $10 per share and then the stock price rises to $15.00, they can realize a profit of 50% by selling the shares.
History of Stock Trading
Modern stock trading began with the trading shares at the East India Company of London, even though stock trading in Antwerp dates back to the mid-1500s.
The Early Days of Investment Trading
In the 1600s, the British, French and Dutch governments granted charters to several companies with East India as their name. All the goods that were brought back from East India had to be transported by sea. This involved risky journeys, often accompanied by pirates and severe storms. Ship owners would usually seek out investors who could provide financing as collateral to mitigate the risks. Investors received a share of the money realized by the ship if it returned successfully with goods to sell. Many of these limited liability companies were only able to last for one trip.
The East India Company
In the end, the East India Company was formed in London, which led to the creation of a new type of investment. Importing companies offered stocks that represented a fractional interest in the company. This allowed investors to earn investment returns based on the proceeds of all voyages that the company had funded rather than just one trip.
This new model allowed companies to request larger investments per share and increase their fleet size. The fact that these companies were protected from competitors by royal charters made them very attractive to investors.
First Shares, First Exchange
The London Stock Exchange was formed in 1773. Although company shares were initially issued on paper and investors could trade them with each other, there were no regulated exchanges until then. Although there was a lot of turmoil immediately following its establishment, the exchanges managed to grow and survive throughout the 1800s.
The beginnings of the New York Stock Exchange
The New York Stock Exchange was founded in 1792. The Philadelphia Stock Exchange was the first stock exchange on U.S. land. However, the NYSE quickly grew into the most dominant stock market in the United States. The NYSE was strategically located near some of the largest companies and banks in the United States, as well as a major port. The exchange set up listing requirements and imposed hefty fees at first, which allowed it to become wealthy.
Modern Stock Trading: The changing face of global exchanges
The NYSE was largely uncontested for over two centuries in the United States, with its growth primarily driven by a growing American economy. The LSE dominated the European stock market, but the NYSE was home to an increasing number of large corporations. France and Germany were among the major countries that eventually created their stock markets. However, these exchanges were primarily seen as stepping-stones for companies to list with either the LSE or NYSE.
In the late 20th Century, stock trading expanded to other exchanges. This included the NASDAQ. The NASDAQ became a popular home for burgeoning tech companies, and its importance increased during the boom in the technology sector of the 1980s & 1990s.
The NASDAQ was the first exchange to operate between a network of computers which electronically executed trades. The electronic trading process made trading easier and more cost-effective. The NASDAQ and the stock exchanges of Australia and Hong Kong were increasing their competition with the NYSE.
The NYSE eventually merged with Euronext in 2000, formed by the merger of Brussels, Amsterdam, and Paris exchanges. In 2007, the NYSE/Euronext merger created the first transatlantic exchange.
How stocks are traded – Exchanges & OTC
The majority of stocks are traded at exchanges like the New York Stock Exchange or the NASDAQ. Stock exchanges are marketplaces that facilitate the buying and selling of stocks between investors. Government agencies, such as the Securities and Exchange Commission in the United States, regulate and oversee stock exchanges to protect investors against financial fraud and keep the exchange market operating smoothly.
OTC stocks are stocks that are not listed on an exchange. They are sold by a “market maker” or dealer who deals specifically with them. OTC stocks do not meet minimum requirements or other criteria for listing on exchanges.
OTC stocks do not have the same reporting requirements as those listed on exchanges, making it more difficult for investors to get reliable information about the companies that issue such stocks. OTC stocks are usually much less liquid than exchange-traded stocks, so investors have to deal with larger spreads between the bid and ask price for an OTC share. Exchange-traded stock spreads are relatively small, and the stocks tend to be more liquid.
Stock Market Players: Investment Banks, Stockbrokers, and Investors
Stock market traders are many.
Investment banks are responsible for the initial public offerings (IPOs) of stocks that occur when a company decides to offer stock shares in order to become publicly traded.
An example of an IPO. An investment bank will act as an “underwriters” for a company that wants to offer its shares to the public.
After researching the company’s total value and considering what percentage of ownership it wishes to relinquish as stock shares, the investment bank handles the initial issuance of shares on the market for a fee while guaranteeing a minimum price per share. The investment bank has a vested interest in ensuring that the company’s shares are sold for the highest price possible.
Large institutional investors, such as pension funds and mutual fund companies, are the most common buyers of shares offered by IPOs.
The IPO is also known as the initial market. After a stock is issued on the primary market, it will be traded through stock exchanges. This is called the secondary market. The term “secondary markets” can be misleading, as this is where the majority of daily stock trading takes place.
Stockbrokers buy and sell stock for their clients, who can be institutional investors or retail investors.
Equity research analysts can be employed by investment banks, stock brokerages, mutual funds, or hedge funds. They research publicly traded companies and try to predict whether their stock price will rise or fall.
Fund managers and portfolio managers are key stock market players because they purchase and sell large amounts of stocks. When a mutual fund invests heavily in one stock, the demand alone can drive its price up.
Stock Market Indexes
Stock market indexes reflect the overall performance of the market. They consist of a collection of stocks chosen to represent this performance. Stock indexes are also traded as futures and options contracts on regulated exchanges.
The Dow Jones Industrial Average, Standard & Poor’s 500 Index, Financial Times Stock Exchange 100 Index, Nikkei 225 Index and NASDAQ Composite Index are all important stock market indexes.
Bull and Bear Markets and Short Selling
The “bull” market and the “bear” market are two of the most basic concepts in stock trading. Bull markets are stock markets where the prices of stocks are generally on the rise. In this type of market, most investors thrive since the majority are stock buyers rather than short sellers. When stock prices are declining, it is called a bear market.
Short selling can be profitable for investors even during bear markets. Short selling involves borrowing shares that an investor does not own from a brokerage that does. The investor sells these borrowed shares on the secondary market and then receives money from that sale.
If the price of the stock declines in the direction the investor expects, the investor will be able to make a profit if they purchase enough shares to pay back to the broker what they borrowed.
If, for example, an investor believes the price of stock “A” will decline from the current $20 per share, then he can deposit a margin to borrow 100 shares from his broker. The investor then sells the shares at $20 per share or the current price. This gives him $2,000. The investor then sells the shares for $20 each, which gives him $2,000, and then returns the 100 shares to his broker at only $1,000. He will then have a profit of $1,000.
An Analysis of Stocks: Market Cap, Earnings Per Share (EPS) and Financial Ratios
Investors and stock market analysts may use various factors to determine a particular stock’s future price direction. Here are some of the most common variables used in stock analysis.
The market cap of a stock is the value of all outstanding shares. A company with a higher market cap is usually more established and financially stable.
Exchange regulatory bodies require public companies to provide regular earnings reports. Market analysts carefully monitor the quarterly and annual reports, as they provide a good indication of a company’s performance. Earnings per share are one of the most important factors analyzed in earnings reports. This reflects the company’s profits divided by the number of outstanding shares.
Investors and analysts also examine financial ratios to determine the economic stability, profitability and growth potential of publicly traded companies. Investors and analysts look at a number of financial ratios.
P/E Ratio: The ratio between a company’s stock price and its earnings per share. A higher P/E indicates that investors expect to see the company grow and their stock price rise.
Equity to Debt Ratio This is an important metric for measuring a firm’s financial health. It shows how much of the company’s operation is funded by debt and what percentage by equity investors. A lower debt-to-equity ratio indicates primary funding by investors.
Return on Capital (ROE Ratio ) The ratio of return on capital (ROE), which shows a company’s net profit in relation to its total equity investment, is a good measure of its growth potential.
Profit Margins There are many profit margin ratios investors can consider. These include operating profit margin, net profit margin, and profit margin. Profit margin is a better indicator of a company’s profitability than a dollar figure. If a company shows a $2 million profit, but that only translates into a 3% margin, any decline in revenue could threaten its profitability.
Other financial ratios commonly used include the return on asset (ROA), price to book ratio (P/B), current ratio, and inventory turnover ratio.
Value Investing vs Growth Investing – Two Approaches for Stock Market Investing
Analysts and investors use a variety of methods to select stocks, but they all follow one of two fundamental strategies: value investing or growth investment.
Value investors invest in companies with a proven track record of profitability and that offer a regular dividend income. Value investing is less focused on growth than it is on avoiding risks, but value investors will still buy stocks if they believe the price is an undervalued bargain.
Growth investors look for companies with exceptional growth potential to maximize the appreciation of their share price. They are less concerned about dividend income and more willing to take risks when investing in young companies. Because of their high potential for growth, growth investors often favour technology stocks.